Tesla’s “Awkward Phase”: Car Profits Keep Shrinking, AI Story Gets More Expensive
Cumulative revenue over the past 12 months has surpassed $100 billion for the first time, but second-quarter profit has dropped to just $400 million. It's becoming increasingly difficult for Tesla to make money from its automotive business, while its AI business is burning through cash at an even faster pace. Tesla is currently in its most expensive transition period—its old engine is slowing down, the new one has yet to generate profits, yet the 467x P/E ratio has already priced in future success.
A record-breaking earnings report, but the stock price still dropped 4% after hours.
After the US stock market closed on July 22, Tesla released its FY2026Q2 results. Revenue reached $28.24 billion, up 26% year-on-year, and cumulative revenue for the past 12 months exceeded $100 billion for the first time. Adjusted EPS was $0.33, falling short of the market's expected $0.51 by 35%. Operating profit came in at $398 million, with the operating margin dropping from 4.1% to 1.4%. Revenue rose 26%, but profit dropped 57%.
It's true that revenue is at a record high, but the decline in automotive profits is outpacing the growth of AI revenue—the gap in between is currently Tesla’s most awkward reality.
The Truth About Gross Margin
Gross margin in Q1 was 21.1%, but plummeted to 16.8% in Q2, a 4.3 percentage point “crash” that spooked the market.
But Q1’s high figure was deceptive. It included a $230 million warranty reversal and over $200 million in tariff credits, both one-off factors that artificially boosted the gross margin. Excluding these, Q1's real gross margin was about 17.5%, while Q2’s was 16.8%, a difference of only 0.7 percentage points.
0.7 percentage points isn’t too large, but the trend remains a gradual decline. Automotive gross margin (excluding credits) was 16.3%, dropping steadily each quarter from 17.2% a year ago.
The real warning sign is in the operating margin, which dropped from 4.1% to 1.4%. Of the 2.7 percentage point drop, the majority was due to a 47% surge in operating expenses—AI R&D, ramping up new products, and the amortization and depreciation of computing power, all of which were areas management intentionally ramped up investment.
Regulatory credits revenue also fell from $380 million in Q1 to $146 million. This is a structural rather than a one-off decline. As other automakers advance electrification, supply and demand in the credit market have reversed, making it tougher for Tesla to cash out this "free profit coupon."
[Figure 1: Revenue Recovery vs. Margin Plunge]
FSD: Buy Software, Get a Car
In North America, the FSD take rate for new vehicles was 55%, and there were 1.48 million global paying users, up 56% year-on-year. During the earnings call, Elon Musk said something interesting: "A lot of people come into our stores saying they want to buy FSD, with a car as an add-on."
FSD is $99/month, with extremely high profit margins. 1.48 million users × $99/month equals roughly $1.76 billion in annualized revenue. This is already Tesla’s second-largest revenue source. With over half of buyers opting in, FSD is evolving from an "optional add-on" to a "default option." Once more than half of new car buyers choose FSD, Tesla is no longer just selling cars.
But there’s a contradiction here: the higher the FSD penetration, the larger the share of software revenue, meaning gross margin should rise. Yet margins are sliding. The costs of AI R&D and computing depreciation are growing much faster than FSD revenue. Software hasn’t yet reached a scale where it can cover the investment.
Tesla is going through a transition: automotive profits are declining while AI revenue grows, but the latter is still too small to fill the gap left by the former.
$5.789 Billion in Quarterly Capital Spending
Q2 CapEx reached $5.789 billion, up 142% year-on-year and nearly doubling quarter-on-quarter. Full year guidance is over $25 billion, with continued growth projected in the next 2–3 years.
Free cash flow turned negative, to -$1.09 billion. But operating cash flow was $4.697 billion, up 85% year-on-year—operational cash generation is strong, but swallowed by CapEx. Tesla’s $43.5 billion cash reserve will last a long time.
Musk described this as "the fastest industrial scale-up in the US since World War II." The Cybercab production line, Optimus production line, Dojo supercomputing cluster, next-gen AI hardware R&D, and the self-built TeraFab chip plant—site selection will be announced soon. CFO explicitly stated: free cash flow is expected to turn positive in 2029.
In a word: from now until 2029, Tesla will keep burning cash.
Robotaxi Adds Points, Optimus Takes Time
The Cybercab has been put into production, and Robotaxi covers seven metropolitan areas. 380,000 miles of unsupervised driving, with zero major incidents. Version 15 FSD is being tested fleet-wide. Weekly mileage is growing by double digits.
The safety record is a plus. 380,000 miles with zero major accidents is a more impressive feat than Waymo over the same period.
Optimus is progressing more cautiously. Musk admitted, "Every robot component is new, there is no supply chain." The first production line at the Fremont factory is being installed—replacing the original Model S/X line. The forecast is for 100,000 units a month in five years, but the early part of the S-curve will be "long and flat." The ramp-up will be a long process.
Tesla’s relationship with SpaceX is deepening. Starlink will be integrated into Robotaxi to ensure network connectivity. TeraFab's chip fab site will be "announced very soon." Tesla’s SpaceX equity holdings yielded $1 billion in unrealized profit. On the merger question, it was avoided: "The earnings call is not the place for this discussion."
467x P/E and 3.8% Return on Invested Capital
In Morgan Stanley’s $417 price target, the automotive business only accounts for $47. The remaining $370 comes from the AI narrative—Robotaxi, Optimus, FSD.
467x forward P/E, 3.8% ROIC. Quarterly profit is only $400 million, but the market cap exceeds $80 billion. At the current valuation, capital efficiency is "destroying value."
Analysts are split into two camps. The "auto fundamentals" camp cares about gross margin and EPS, and misses make them more cautious after earnings. The "AI narrative" camp focuses on FSD penetration and Robotaxi progress; a 55% take rate and zero accidents reinforce their confidence.
The divide is growing: short-term profit deterioration and long-term AI bets are progressing simultaneously. A 467x P/E means the market is already paying for the 2029 story, but the valuation pressure during this three-year negative cash flow period is real.
[Figure 2: Beat/Miss vs Consensus]
The Next Watchpoint
Three signals to watch for in Q3:
- Whether FSD take rate can continue to rise from 55%—the core indicator for Tesla’s transition from car company to AI company
- Whether CapEx continues to accelerate—will the $25 billion annual guidance be raised to $30 billion
- Whether gross margin can stabilize in the 16.3–16.8% range—if it keeps falling, the story of "sacrificing profit for the future" won’t hold
Tesla is funding its AI ambition with automotive profits. Revenue hit a record $28.2 billion, but profit dropped to just $400 million. Free cash flow turned negative, and the company is burning cash through 2029. The $43.5 billion cash reserve will last a while. The question is, after the cash burn, will AI investment pay off?
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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